THE DISTILLERY: China connection

Jotters dig around for the link between the Reserve Bank's latest policy statement and Fortescue's decision to scale back expansion plans.

What links the Reserve Bank of Australia’s monetary policy statement and iron ore miner Fortescue Metals Group’s production expansion cut backs is China’s appetite for stimulus. Many of Australia’s business commentators have tried to bridge the gap between the two, while keeping in mind the excess iron ore production in China that’s running at a loss with prices as they are. It’s just one mineral, but it’s so crucial to Australia’s wellbeing.

But first, The Australian Financial Review’s Robert Guy has perhaps the most important story this morning because he addresses the prospect of stimulus in China directly, through the unlikely prism of the humble soybean. The problem for Beijing is that the price of soybeans has risen terribly fast.

"It is the role of soybeans as pig feed that may trouble officials at the People’s Bank of China, given the high weighting of pork in China’s consumer price index. The concern is that higher feed prices will lead to higher pork prices, which will underpin a rise in measures of inflation. Food accounts for about 30 per cent of the CPI and pork accounts for about 10 per cent of the food basket used in the construction of the index… The Communist Party is sensitive to food prices as they are viewed as key to social stability – an outcome Beijing wants to ensure as it heads towards its once-in-a-decade leadership transition later next month.”

Now, when considering the commentaries to come, it’s important to remember not to confuse Beijing’s desire to keep food inflation low with any plans to reduce unprofitable local iron ore production, once thought to provide a price floor for the commodity. The two are not mutually exclusive.

But when commentators talk of another round of stimulus from Beijing to boost the slowing economy, Guy’s commentary serves as a reminder that it won’t be this big blanket of money that boosts the entire economy without discrimination. Its primary goal is not to boost demand for Australian resources. Indeed, this morning, The Australian’s John Durie describes the confidence that Australian mining chief executives have in the ability of China’s leadership to manage its slowdown as "blind faith”.

Fairfax’s Malcolm Maiden delivers a clinic in Reserve Bank-speak, explain how the central bank largely said the same thing this month as it did last month, with two subtle differences, China being one of them.

"Its commentary on China's growth has also become more cautious. A month ago, it said that China's growth had ‘moderated to a more sustainable pace, but does not appear to be slowing further’. Yesterday it said much the same thing, but also said ‘some recent indicators have been weaker, which has added to uncertainty about near-term growth’.”

The two journalists that bridge the gap best between the Reserve Bank’s rates decision and Fortescue’s plan are The Australian Financial Review’s economics editor Alan Mitchell and Fairfax’s Peter Martin.

Mitchell points out that the Australian dollar’s persistent strength would normally aid the more marginal projects, while Martin contends that the RBA would be particularly concerned about Fortescue’s news. The writer argues that, unlike BHP Billiton’s cancellation of Olympic Dam, Forrest’s plans were well underway already.

The Australian’s Barry Fitzgerald explains how, even with the iron ore miner’s actions, Fortescue’s earnings margin of $US15-$US20 a tonne before interest, tax, depreciation and amortisation is still very thin for a company with its debt.

"To be fair, the company is not alone in banking on a return to $US120 a tonne iron ore prices. Just about every analyst in the country has been guessing the same, all of it premised on the notion that the low prices will knock out high-cost Chinese production, which will be replaced with lower-cost stuff from the Pilbara. Students of history are not so sure. They point to the rise and rise of steel production in Europe, then US and then Japan at various stages in history.”

The Australian Financial Review’s Matthew Stevens cleverly rechecked his diary to discover just how quickly Fortescue chief executive Nev Power has changed his public tune on the iron ore miner’s capex intentions.

"As recently as last Thursday, chief executive Nev Power was confirming confidence shaken but not stirred in a speedy recovery to peak iron ore prices and telling anyone who would listen that Australian iron ore’s third force was committed to its $US6.2 billion capital spending program for the 2013 fiscal year. ‘We expect to see iron ore prices return to the $120 to $150 range in short term to medium term,’ Power enthused on a media call that punctuated Thursday’s calendar of investor briefings and public speaking. But, by yesterday, apparently after a round of weekend deliberations over a heavyweight cost review that was not flagged in Power’s public commentary, Fortescue was trimming $US1.9 billion from its capital and operational spending plans and reducing its long-held near-term growth target from 155 million tonnes per annum to a more modest 115mtpa.”

Business Spectator’s Stephen Bartholomeusz made the same observation about Power’s public statements, adding to his analysis from last week about the market oversupply. This remains the best summation of the iron ore market from any Australian commentator. Jamie Freed, the AFR’s resources reporter, said the miner didn’t raise the prospect of a capital spending delay in its meetings with fund managers last week either. Although, Fairfax’s Adele Ferguson reports that Fortescue made a few calls to "valued contractors and mining services clients” last night about the pending announcement.

Fairfax’s Elizabeth Knight watched the Fortescue announcement combine with warnings from ratings agencies to push the iron ore producer’s share price lower. The short-sellers had a field day.

Elsewhere, The Australian’s Richard Gluyas looks at the embarrassing court battle National Australia Bank is currently engaged in.


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